Energy Insurance

The vast majority of scientists who study climate issues now agree that carbon emissions are a potentially disastrous problem. However, economic fears have obstructed even the mildest remedies. Particularly in the United States, voters resist taxes that would raise fuel costs, and there has been little political support for massive investment in new technologies or mass transit systems.

Yet there are also some less painful ways to cut greenhouse gases. One is to change how the nation buys its automobile insurance. If people paid for insurance on a per-mile basis, instead of in a lump sum, it would provide a substantial disincentive to drive--about the same disincentive as a $1.50 per-gallon gas tax. This in turn would reduce the number of miles driven by 10-20 percent. Less driving would mean fewer accidents, which would then lower the cost of insurance. So "clean" (pay by the mile) insurance may be the biggest free lunch around in reducing greenhouse gas emissions.

To take an example from Todd Litman of the Victoria Transport Policy Institute, imagine buying gasoline the same way you buy car insurance. Once or twice a year, you would get a bill based on how much gas people like you tend to use on average. After you mailed in your check, you could drive around and use as much gas as you wanted. You could just show up at a gas station, fill up, and drive away without reaching for your wallet. Imagine how many more trips we would take, and how much more pollution, congestion, and accidents would result. Imagine how much hotter the earth might end up.

Pay-by-the-mile policies would stop pricing car insurance like an all-you-can-eat buffet. The idea recognizes that the true cost of insurance (the risk of accidents) is related to the number of miles driven. Even under the current, fixed-price insurance system, most insurers do offer low-mileage discounts, but they acknowledge that these do not come close to capturing the actual difference in risk.

The average cost of insurance in the United States is presently about $900 per year. The average vehicle is driven about 12,000 miles. If insurance were billed at a constant per-mile rate, the cost would be 7.5 cents per mile. For the statistically average person who drives exactly 12,000 miles, this shift poses no net increase in cost. She ends up paying $900 per year, just as before. But now she could save on her insurance if she drove less. For example, if she drove 10,000 miles instead of 12,000 miles, she would pay only $750 for her insurance, saving $150. By contrast, high-mileage drivers would pay more for insurance since such drivers have a greater risk of accidents, other things being equal. There is no obvious social purpose served by forcing people who have little accident risk to subsidize people who have high accident risk.

Of course, the real world is somewhat more complicated. People are not equally safe drivers. Also, not all miles are the same. A driver is far less likely to be in an accident on a rarely used rural road than on a congested urban highway. These factors would have to be taken into account in setting fees for pay-by-the-mile insurance, just as they are under the current system. A person with a bad driving record should be paying more per mile for insurance than someone who has never been in an accident. Whatever rate is implied by the person's driving history and other factors would simply be assessed on a per-mile basis rather than a per-year basis. For example, a particularly reckless driver may currently pay $1,500 a year for insurance: This would translate into a fee of 12.5 cents per mile, instead of the 7.5 cents per mile that an average driver would pay. Likewise, if high-mileage drivers are likely to drive mostly on comparatively safe highways, then these miles should perhaps have a relatively low cost, like three cents per mile.

There are also issues concerning verification. Drivers would have an incentive to understate the number of miles driven in order to pay less for their insurance. One way for insurance companies to verify mileage is to require certified mileage readings whenever a claim is filed. Another way is to use mileage readings that are a part of required automobile inspections in roughly half the states. Perhaps the easiest approach is to pay for the basic part of insurance through the gasoline tax. People who drove more would simply pay for their insurance as they purchased their gas.

While the mechanics of pay-by-the-mile insurance do present difficulties, none of the problems is insoluble. We know this because a major insurer, the Automobile Club of Southern California, has been profitably selling pay-bythe-mile insurance for the past four years. They have found that mileage verification and the other problems associated with pay-by-the-mile insurance are all quite manageable, and see no reason to revert back to the standard fixed-rate system of billing.

Pay-by-the-mile insurance is the sort of market-based environmental policy that conservatives should relish. Though one can envision the heavy hand of government requiring that all insurance policies be pay-by-the-mile, much can be accomplished with modest incentives and simple forms of government support.

Since insurance is regulated primarily at the state level, states can experiment with a variety of approaches. They could foster pay-by-the-mile policies just by facilitating mileage verification. For example, a state can require that mileage readings at automobile inspections are turned over to insurers, a procedure that the Automobile Club of Southern California relies on for its mileage verification.

Going a little further, federal, state, or even large local governments could implement pay-by-the-mile insurance procurement policies for insurance on their own fleets of cars. This should promote the spread of these policies by establishing a market and making insurers more familiar with their use. States could also change their own method of charging for car licenses and registration. Currently, these fees are assessed on a fixed basis, averaging $230 per vehicle per year. States could convert to a per-mile charge, which would be the equivalent of a 39-cent-per-gallon gas tax. Here again, the mileage information that states used in assessing these fees could be shared with insurers.

A modest tax credit for pay-by-the-mile policies (for example, $100 a year) is the sort of incentive that states (or the federal government) could implement to promote clean insurance. A credit of this magnitude should give consumers a substantial incentive to seek out pay-by-the-mile policies and, therefore, will encourage insurers to offer such policies. This type of program is almost certain to be relatively cheap since it could be quickly ended if a large portion of drivers switched to pay-by-the-mile policies. If most people prefer pay-by-the-mile insurance to standard policies, then there would be no reason for the government to subsidize it.

Switching over to pay-by-the-mile insurance policies offers enormous environmental benefits with no obvious drawbacks. The predicted reduction in miles driven should be sufficient to bring about half of the emissions reduction needed in the transportation sector under the Kyoto agreement. Furthermore, in addition to helping the environment, the resulting reduction in miles driven would also lead to less congestion and fewer accidents and injuries.

Obviously, the country will have to do more than switch over to pay-by-the-mile insurance policies in order to reverse global warming. Other measures are likely to be more costly. But whatever else might be necessary, it seems foolish not to take advantage of the free lunch sitting in front of us on the table. Besides, shouldn't insurance agents be heroes once in their life? ¤